Getting to "yes" in a world of "no"…

From my dusty startup garret, I have to say that there’s something Just Plain Wrong with the way the Chancellor of the Exchequer George Osborne sees the world of small business. On the one hand, his 2011 Autumn Statement announces the Great Big Match-Funding Angel Bribeformerly known as BASIS (which even the BVCA now openly calls a “liberalisation” rather than a “simplification”):-

[p.7] The Government will: […]

launch a new Seed Enterprise Investment Scheme (SEIS) from April 2012, offering 50 per cent income tax relief on investments, and will offer a capital gains tax exemption on gains realised in 2012–13 and then invested through SEIS in the same year;

Now, unless I’ve missed something really obvious this surely means that UK angels now have an exceptionally good reason not to invest in anything between now and April 2012 when the scheme goes live (subject to subsequent European ratification, which is by no means certain). But then again, it already takes such a ridiculously long time to close an investment round these days (9 months? 12 months?), the entrepreneurs most likely to be inconvenienced are those who are trying to close a round right here right now. So, even though it’s a great bribe, nobody should expect to see a tsunami of UK startup investment on TechCrunch in the next six months, OK? *sigh*

On the other hand, the Government really, really wants to find a way to encourage banks to lend to SMEs, though apparently with neither a carrot nor a stick…

[p.7] The Government will: […]

introduce a National Loan Guarantee Scheme. Up to £20 billion of guarantees for bank funding will be made available over two years. This will allow banks to offer lower cost lending to smaller businesses, subject to state aid approval;

Hilariously dismal! As my business bank manager patiently explained to me last month, UK banks don’t want to lend to small businesses for the simple reason that they are now measured by their balance sheet. So, unless that startup happens to have any kind of collateral to put up (and no, intangible stuff such as IP and patents doesn’t count, but thank you for asking), the answer is basically going to be a no at any price – reducing the potential spread by 1% will make no difference if the lending decision pointer remains rusted on [NO].

So it would seem the government has painstakingly constructed a microeconomic lending lever to pull that isn’t connected to any actual banking machinery. On the bright side, if no bank takes up the offer, this could be the cheapest policy announcement ever (if admittedly also one of the least effective).

Plainly, the Government knows that SME lending is just plain broken: the level of lending done under the Enterprise Finance Guarantee scheme has continued to collapse over the last couple of years, for the simple reason that the banks now have no incentive to lend to startups at any price. Moreover, surely the way that Project Merlin has manifestly failed to deliver any real lending to SMEs (i.e. not converting overdrafts to factored lending at gunpoint) is as big a red warning flag as the Government could ever require? Why is nobody talking about why Project Merlin has failed? The most relevant commentary I could find on this seemed to amount to a big shrug, that maybe this revised scheme somehow replaces Project Merlin?

Oddly, the macro shift in bank lending strategy from working capital to invoice factoring came at the moment when invoice factoring become (sort of) democratized via independent platforms such as MarketInvoice. So if working capital & lending is history, and even factoring is better done elsewhere, what really are UK business banks now for? With the High Street in freefall, the poor dears haven’t even got coffee shop franchise presentations to lend against now. It’s tough being a bank when you don’t actually want any customers, right?

And finally… on the third hand (there’s always a Third Way with modern government, thanks Tony),

[p.7] The Government will: […]

make available an initial £1 billion through a Business Finance Partnership, which will invest in smaller and mid-sized businesses in the UK through non‑bank channels.

If you’re a startup looking at this, all you basically need to know is that the chance of any of this money arriving in your direction is zero. No, by “smaller” they don’t mean you at all, they mean established companies that aren’t quite as big as they’d like. Just so you know!

Chris: the first thing I’d do is prevent banks from forcing entrepreneurs to borrow against their primary residences as part of EFG. The old SFLG didn’t do that, it seems as though the banks watered it down in the transition to EFG, and they’ve progressively hardened their position over time. Secondly, the government should also ratchet up the percentage of an individual bank’s EFG portfolio it covers for defaulting: this is too low, it isn’t helping things. Thirdly – and biggest of all – I think the banks need actual quarterly targets (i.e. not pretend Merlin targets) for real SME lending (i.e. not companies with >£1m turnover), linked directly to agreed penalties (i.e. not more “sorry, Chancellor, we tried” Merlin handwaving). The banks have spent the last three years cleansing their portfolios of overdrafts and working capital facilities to try to dilute the effect of their unshiftable toxic debts, directly because the current system clearly incentivizes them (a) not to disclose, and (b) not to lend. That’s what’s broken here, and that’s what I think needs fixing.

Overall, the UK government seems to have a collective misconception that entrepreneurs are all Ramen-eating 20-something graduates hotdesking in Shoreditch, when that’s really the ‘wantrepreneur’ demographic. ‘Real’ entrepreneurs tend to be older and have industry experience and active networks… and families, and houses.

Moreover, UK business is somewhat like a giant pyramid, with a small number of big companies massively outnumbered by the small companies at the bottom. Yet I think it’s the small companies at the bottom that have been disproportionately affected by the shift in the lending landscape.

Yes, I do get cross… but that’s because I care about it. I discuss all this stuff, and lobby the Treasury & BIS. Hasn’t worked yet, true, but I keep trying. 😉

Dear Nick, good points all…. the banks are sh*t scared of lending to small businesses, and that ain’t gonna change any time soon with what’s going on with European cousins basically having crippled the sovereign debt market – if you can;t lend to a country, who the hell can you lend to?

It would have been great if, as you pointed out, this significant change to the EIS had been announced from today – really, why wait? I guess the CGT is the key here, as the UK Govt is effectively turning their tax pot into a giant potential fund controlled by individuals who can invest in these early stage start ups, so that in itself is a great thing – but it is just a shame about the chronology of it.

Rupert: for me, it all comes down to where in the economy you think is the best place to put a carrot or a stick. For me, find ways of supporting (not even ‘backing’) a thousand small companies with intangible capital and a reasonable prospect of exporting and you’ve got something that can make a real macroeconomic difference.

So perhaps the real solution here is a government bank that is tasked with specifically lending against intangible assets, something which (as I understand it) only Lloyds TSB ever did, and even then only for a short period of time circa 1999. Ho hum!

Agree with the post that this will almost certainly cause an initial “drying up” of any deals that are about to go through, as the incentive to wait 4/5 months is outstanding. But don’t shoot it down just yet, as there could be a huge injection of money into start ups (disclaimer: my company, digitalle, is in a “semi-seed” fund-raising round at the moment), as essentially anyone who is due to pay CGT in 2012-13 could re-direct that money to invest in a start up. There are also other benefits in investing in EIS which this is, so this is exactly what we need in the absence of “high street” bank lending.

Any investors out there looking for a fantastic opportunity are very welcome to get in touch with us, as we are doing some ground-breaking work within the online security and authentication arena. If you would like to learn more, please drop me a linked in at: http://uk.linkedin.com/in/ruperthurley

Rupert: I agree that the post-2012 SEIS & CGT reinvestment treatment could provide an excellent surge to those in the startup segment who qualify… if your startup can last that long on the shelf without folding. =:-o

Also, don’t forget there’s the 30% holding ceiling in SEIS (as per HM Treasury’s BASIS proposals), which a number of angels I’ve spoken to oppose vehemently, so it’s not exactly “EIS+”; and there’s the Treasury’s watered-down liquidation prefs stuff to consider too… things to bear in mind!